About the author

Mark J. Perry is concurrently a scholar at AEI and a professor of economics and finance at the University of Michigan's Flint campus. He is best known as the creator and editor of the popular economics blog Carpe Diem. At AEI, Perry writes about economic and financial issues for American.com and the AEIdeas blog.

Great moments in government regulation: Commodity Futures Trading Commission shuts down Intrade for Americans

The Commodity Futures Trading Commission (CFTC) has filed a civil complaint in federal district court that has shut down Intrade (mentioned on CD more than 100 times), the popular Ireland-based online prediction market, to Americans.

It is against the law to solicit U.S. persons to buy and sell commodity options, even if they are called ‘prediction’ contracts, unless they are listed for trading and traded on a CFTC-registered exchange or unless legally exempt. The requirement for on-exchange trading is important for a number of reasons, including that it enables the CFTC to police market activity and protect market integrity. Today’s action should make it clear that we will intervene in the ‘prediction’ markets, wherever they may be based, when their U.S. activities violate the Commodity Exchange Act or the CFTC’s regulations.”

The CFTC’s real complaint is that consumers eagerly bet on Intrade because the company exemplifies market integrity: “I trust Intrade with my money because of their reputation, not government regulation.” Reputation: That’s the same mechanism, of course, that underlies eBay, Amazon Marketplace, and the whole cornucopia of internet commerce that the mainstream information economist of 1990 would have dismissed as free-market Fantasy Island.

Americans send money to Intrade because Intrade delivers the goods (and produces the positive externality of accurate forecasts in the process!). In the information age, firms’ reputations are just a click away. That’s all the protection any consumer needs. The only people the CFTC is “protecting” are its own obsolete employees.

MP: So it seems like Intrade didn’t get the required “permission slip” from U.S. regulators to offer its prediction contracts to adults in America, who apparently need government regulators to “police market activity and protect market integrity.” The fact that the CFTC hasn’t received any complaints from American traders and the reality that Intrade “exemplifies market integrity” apparently don’t matter to the overzealous regulators at the CFTC.

Discussion: (40 comments)

the big trading networks (nyse, nasdaq, cme etc) have all been taking big hits because, despite their government regulated oligopolies/monopolies, their reputations are shaky.

they front run trades (yes amex specialists, i’m looking at you), they preference certain traders (like the high frequency guys) over others with faster access to the computers, and they use client info to prop trade.

they have been hemorrhaging business to dark pools (many of which are also very, very shady and just fronts for high f guys) and to the ecns.

this is because reputation matters. why they chose to go after intrade in particular is a bit odd, but the basic notion is that they do not want to compete on reputation, but rather incumbency and federally mandated oligopoly.

it all comes back to bastiat’s notions of “look at everyhting from the perspective of the customer”. this is the opposite. customers are not being protected, but rather limited in their choices to protect entrenched interests.

The AMEX no longer exists and neither does the specialist system. The replacement DPM system doesn’t give DPM’s the advantages specialists had. In fact, you’d have to be an idiot to want to be an equities market maker these days. Despite incessant bitching by the likes of Zerohedge, HFT doesn’t receive any special preference except. HFT does a lot of volume and exchanges are forever trying to attract volume for obvious reasons, so any high volume trading shop will find itself aggressively sought after. Complaining about that is like moms and pops complaining they don’t get the same discounts from wholesalers that Walmart does. HFTs are just scapegoats in the same way that computers are scapegoats for talentless floor traders who depended on favouritism from certain brokers, a particular spot on the floor and for all volume to be funneled through them so that they could rape orders and now can’t compete in a much broader and competitive market created by electronic trading.

Your complaints are all about markets that are perverted by the SEC, not the CFTC.

The specialist system (as well as the AMEX and all of its market makers and specialists) disappeared years ago. The replacement DPM system doesn’t have any of the same advantages or obligations. In fact, you’d have to be a masochist to be a market maker in equities today. You get additional tax disadvantages piled on top of the rising cost of regulation and none of the exemptions. We recently yanked one of our equity bd’s and we are among the last (the ones that remain are those shady prop shops like Bright).

Despite endless bitching by the likes of Zerohedge, there are no special preferences for HFT. These guys do a lot of volume and exchanges are always searching for volume. Complaining about HFT is like small stores complaining that Walmart gets better prices from its suppliers. Duh. However, there is plenty of blatant preference for the TBTFs – especially Goldman.

Exchanges can’t prop trade. However, clearing firms like Goldman can and do and have a well-earned reputation for outright stealing their customers trades – a step far more bold and obnoxious than the regular theft of trading strategies that Goldman is famous for. Anyone I know who clears through Goldman never clears anything truly proprietary there. ABN AMRO and Merrill don’t do this. In Merrill’s case it’s probably because they’re too dumb.

The hemorrhaging to dark pools is largely in response to Reg-NMS – yet another top-down beauty dumped onto the market by the SEC as a gift to their client large exchanges trying to kill smaller competitors on high volume securities with wall to wall bids and offers. Can we all say “regulatory capture”? Ooops. Unexpectedly, here come the dark pools which the exchanges now have to figure out how to compete with because they’re too large to simply rule out of existence.

Regardless of which alphabet soup reg agency we’re talking about, the effect is the same – a disorderly market that serves nobody but insiders.

fair point. i was mostly just tossing out examples with which i am familiar. it’s the same basic genre. i do not trade commodities.

front running from the brokers certainly led to the rise of dark pools and algo trades on ecns.

that said, many of the smaller dark pools would be better named “dark alleys” where the HF guys mug you. some of the bigger and earlier ones (like liquidnet) seem to play it straight but some of the other ones will make you wish you passed out in a tijuanna alley with your wallet in your hand.

exchanges with specialists prop trade all the time. they just call it “making a market”. they have a sneaky tendency to do the clean up print on big orders and ride the lift when the sell pressure is off. they also spill info to guys who will trade on it.

i have zero sympathy for them and the business they are losing. they brought it on themselves. i can sure see why many of them would not want to compete on their reputation for honest dealing and probity.

Your broker is a completely different entity than the market maker (the dealer) and front running there has been a problem. MM’s don’t have access to your information. And large orders have always been worked off-floor because large orders move price. If there were no shadiness on the part of anybody that’s reason enough to not dump your order on the floor. And you best believe that if I, as a market maker, see your giant order coming at me I’ll yank my bid and take it way the hell down. To do anything else is complete idiocy on my part. As an MM I’m not required to lose money for your benefit. In the past we were, but then to compensate MM’s for this obligation and the additional risk, the SEC gave MM’s exemptions and advantages – to which you take exception.

exchanges with specialists prop trade all the time. they just call it “making a market”.

The market makers are not employed by the exchange and aren’t part of the exchange in any meaningful sense – especially not in any way that will lend legitimacy to a claim that “exchanges prop trade”. Exchanges cross trades and perform some other functions, but trading is never one of them and I don’t know why you’re talking about specialists. I keep telling you that the specialist system was scrapped years ago. They don’t exist anymore.

Furthermore, exchanges are not monopolies or oligopolies. Securities are listed on multiple exchanges all over the world and you’re free to direct your order to any of them. In Chicago alone there are at least two stock exchanges, including the Chicago stock exchange and the CBSX. The large exchanges like NYSE would like to kill them (and reg NMS was designed to do just that), but that’s because there is competition in the first place.

they have a sneaky tendency to do the clean up print on big orders and ride the lift when the sell pressure is off. they also spill info to guys who will trade on it.

I have never heard this jargon before, so maybe I just don’t understand what you’re saying and different exchanges have different rules, so your complaint needs to be more specific, but it sounds an awful lot like sour grapes that the guy on the other side of the trade is just a better trader and reads order flow better than the person lodging this complaint.

The probability that a market maker is on the other side of your equity trade is very very low. It’s not economic to be an equity MM anymore. 70% of the equity volume is done by HFT’s and the vast majority of the rest is other large institutions. So, I think what you’re really seeing is the reaction of algos to your orders. In options, on the other hand, the other side of your trade is almost always going to be a market maker.

As far as info, MM’s aren’t privy to inside information about your order. I think you’re confusing brokers and Market Makers again (and if your broker crosses the trade in house or takes the other side, it’s still a broker problem). Once a trade reaches a market maker on the exchange, it is considered public information.

Frankly, I have always thought that the MM system was idiotic. The only reason it exists is because stupid regulations (and I consider virtually every single regulation stupid) have prevented people from acting in their own interest and sucked liquidity out of markets. To re-inject it, the SEC created a class of “market makers” and “specialists” who were exempt from these same idiotic regulations and offered more leverage in exchange for bearing the burden of regulation to re-inject the very liquidity that the SEC’s own regulations sucked out. In other words, it’s a fake designation and an example of solving government-created problems with more government. You know how well that works.

None of that really has anything to do with the CFTC’s latest ban of Intrade, but it does illustrate just how inept regulators are at executing their mission statement: to keep markets “fair and orderly”. This is a function the market best performs without help from those morons.

“And you best believe that if I, as a market maker, see your giant order coming at me I’ll yank my bid and take it way the hell down. To do anything else is complete idiocy on my part.”

precisely, which is why i will not show it to you. i’ll use a dark pool or a set of ecn algos so that you do not see it coming and play “ole!” with me. this is precisely why the MM’s are losing such share. i think you are being a little cute on the “no specialists” claim. changing their name to DMM is not the same as having them go away. they get to snatch 50% of order flow if they are in the bet bid/offer. it’s still a license to steal and penny guys to death.

a rose by any other name…

regarding your “sour grapes” notions, no, that is not it at all. if a DMM can step in at the last second and join a large bid and get 50% of the print, then if he also has the order flow, he gets to see how big a piece is and, unlike anyone else, is guaranteed a big piece of the clean up that completes the order. it’s an advantage no one else has.

if you traded small and micro caps as opposed to big liquid stuff, you would know all about this. it’s not a big deal in spiders, but try moving around blocks that are multiples of average daily trading volume and you will find a very different world. listed smallcaps are a nightmare this way.

i know you know a great deal about the BD/mm biz, but this is a part of that space where it seems you do not, and i think you really are being a little cute saying the specialists went away.

you are correct about the bad economics. it’s worse in the small stuff. this is why they abuse that 50% take ability so badly to see if they can’t find a way to make it worth their while.

in all seriousness, talk to someone who trades microcaps. this is an endemic issue. i’m honestly very, very surprised that you are unaware of it.

Okay, I don’t know what’s going on, but I keep getting a server error, I’ll divide the post and let’s see what happens….

I don’t understand people who understand that everyone works in their own best interest but suddenly forget that when they are personally involved. Of course you should do what’s in your best interest and work your order so that market participants don’t see how big it is. That has always been the case and dark pools as they exist today are merely the latest tool.

Let me get this straight: When you’re trying to hide the size of your order and the valuable information that it might contain from the market, that’s not playing “ole”, but when the other side of your trade is trying to suss out information about your order from the flow that’s playing “ole”? You must be kidding. Why do you expect the other side of your trade (be it market maker or anyone else) to provide you with too much liquidity at a price beneficial to you and at their expense?

Equity MM’s (which you should know are different from DPM’s) fled the business when portfolio margining was introduced in 2007. There are two main reasons: 1.) The markets are more liquid today and spreads are tighter and 2.) The regulatory burden became unmanageable and the benefits too small to make it worthwhile. These firms still have “share” so long as they better the market, just without the negative expectancy of making markets. The only way for today’s market makers to get share is by bettering the market. There were other significant benefits before, but they no longer exist. You’re living in the past, Morganovich.

I’m not being cute. You just don’t seem to know very much about making markets and the DPM (DMM) system vs. specialists. And, btw, illiquid securities are ALL we trade. My firm has always specialized in them (whether equities or derivatives) because it’s really not that profitable to compete in very liquid securities with large companies in command of more resources than our small firm.

First of all, it’s not “abuse” if you are allowed to take 50% of the volume on open and close and you do. They are in compliance. You see less of that in very liquid names because few of them have DPMs anymore and nobody wants to take 50% of enormous volume because of the risk anyway.

Second, this is the only privilege remaining and DPMs have no other privileges from the specialist system. None. They do have obligations, though. DPMs must be on the NBBO a certain percentage of the time and just making markets is negative expectancy. Surely you know this. If there’s a tech glitch and you’re not on the NBBO, you’re hauled in for questioning and fined. You have to constantly prove to the regulator that you were fulfilling your obligations – that alone is a huge cost. I know. Were were DPMs in illiquid securities at the request of our exchange until we realized how unprofitable that business was (now we’re still operating but not even as an MM in equities). Our front end’s systems went down and we weren’t able to get our markets up for the open one morning. Tech failures are a fact of life. Shit happens. The regulator’s response? Tech failure is no excuse. That’s a mighty expensive privilege, my friend.

I know it seems like a huge advantage to you because you do not bear any of the costs associated with this ONE privilege. In fact, few securities have DPMs anymore because it’s so unprofitable.

Think about it: If it’s such an advantage, why would SIG and Goldman get out of equity market making entirely?

call me mr cynical, but i would replace the word “overzealous” in “he fact that the CFTC hasn’t received any complaints from American traders and the reality that Intrade “exemplifies market integrity” apparently don’t matter to the overzealous regulators at the CFTC.”

There isn’t a single regulation that isn’t “bought and paid for”. The activities that are occasionally NOT favours to connected insiders is certain removals of restrictions – elimination of the uptick rule, for instance. Oh, how the market makers all hated it when they had one less rule with which to abuse customer orders (MM’s were exempt, of course, and professional traders had a million ways to get around it). Thank goodness we can always count on the idiot public to argue against interest and demand a re-in-statement of some version.

The gotta justify their existence somehow. As William Randolph Hearst once said: “You provide the pictures, I’ll provide the war.” Although, in this case, I guess it’s “You provide the market, and the regulator will provide the villain.”

On Intrade, you are not actually buying anything. You are betting on the probability of something happening. When you buy a “gold contract” on Intrade, you do not actually own the gold. You bet on the probability of, on a specific date, gold will be higher/lower than today. If you win, you get $10. If you loose, you get nothing. This is really no different than if I went to the roulette table and put my money on 22 Black (well, there is a difference. Intrade does not rely on pure randomness like roulette does).

My question is: how does the CFTC have jurisdiction here? Wouldn’t the government have a stronger case to go after this as illegal online gambling?

as soon as it threatens to take business from the CFTC’s fiefdoms, uh, i mean, once consumers are placed in danger, then they make it their business.

free trade and contract between individuals cannot be tolerated if it dis-intermediates those who pay for political patronage. what next? home sales without realtors? rides to the airport without a taxi medallion? gasp! it’s cats and dogs living together! it’ll be anarchy!

from a purely structural standpoint though, how is an intrade contract any different than a cash settled future?

When you buy oil or some other commodity, you do actually “own” it, if only on paper. You may not have 20,000 barrels of oil sitting in your back yard, but you do have a piece of paper saying you are entitled to those 20,000 barrels. When the time comes, you sell those barrels to some willing buyer. With Intrade, you do not “own” anything.

If it’s physical settle, then you own a PROMISE (a contract) for delivery of the physical commodity in a certain quantity, of a certain quality, at a specific location, at a specific time and for a certain price. The specifics are described in the contract.

If it’s a cash settle, you are never entitled to the underlying commodity. Most commodities contracts today are cash-settle not physical settle. Whether or not you will ever get to touch the underlying is not the defining characteristic. The nature of the underlying is what determines which regulator will get to mess with it.

Hippies and I share a lot of the same goals, but I hate them as they tend to be idiots. Every protest they stage (like Occupy Wall Street) just seems to be some 60’s battle reenactment. They are trapped looking backwards at some glorified past rather than the future.

This is the same CFTC that didn’t lift a finger while the double-dealing CDO/CDS operators brought down the world economy in 2008. But now they’ve effectively shut down a legend of modern innovation because it was competing with the powerful players on Wall Street that the CFTC was actually CHARTERED to regulate.

I guess it’s good to have friends in high places. Sheesh. I’m a Democrat and believe in regulation that protects the safety of the public and stability of the economy. But these vandals at the CFTC need to have their charter revoked before they destroy anything else of value.

The CFTC is not to blame for that. Trust me, I have no love for regulators as they seek to victimize me, but blaming them for things that are out of their control just distracts from the things that are. If you want to blame them for opaque OTC derivatives, blame them for perverting the market so much that some derivatives became so convoluted and opaque that they were (are – the creation of awful derivatives with poorly understood risks but growing leverage continues apace) very dangerous.

This is the same CFTC that allowed MF Global to violate its own haircut rules and then looked the other way as Corzine stole from customer accounts. Let’s all keep in mind that the segregation of customer assets is among the easiest rules to enforce.

From Intrade: We understand yesterday’s announcement was met with surprise and disappointment by our US customers, but this in no way signals the end of Intrade in the US. In the near future we’ll announce plans for a new exchange model that will allow legal participation from all jurisdictions – including the US. We believe this new model will further enhance Intrade’s position as the leading prediction market platform for real time probabilities about future events.

For our non-US customers, we will continue to offer real-money prediction markets. In the coming weeks and months we plan to implement a number of improvements to the Intrade website. These include expanding our market categories, adding more convenient funding options and a new and improved trading interface. We’ll keep you posted on these initiatives as they develop.

This could just be an opportunity to show how regulation DECREASES the reliability (ease of use, consumer protection, etc.) of a private corporation. Also, it will always give us a present-time model at all times in the future to compare the state of US intrade v. non-US intrade. For the long time anti-government fans though, I’m sure that this is just old news.

Unfortunately internet gambling is also illegal, or intrade could slip thru that whole. I suspect that bookies in Las Vegas take the sort of bets intrade takes. Now if you legalized internet gambling then the CFTC would not be involved, as it would be some gaming commission that regulated it, and of course took its cut.